The Smartest Guys in the Room

This post is the longest blog entry that I have written on Leadership and Management, but the book is such an excellent piece of work chock of lessons from the perspective of balancing upside and downside in business. At 419 compact pages, Bethany McLean and Peter Elkind’s book, ‘The Smartest Guys in the Room’, itself is a long read, though it does fly by, but there is much to get through in its comprehensiveness.

And the story is as powerful and full of lessons as any Shakespearian tragedy (which is perhaps the inspiration for the acclaimed stage production ‘Enron’ which I have tickets to now).

The heart of the Enron story is the heart of this blog – risk.  As one of the vaunted analysts quotes asserted, “Rich [Kinder] has figured out how to profit from risk. Consequently, Enron has become a company defined by the way in which is handles risk.”

As every investment advertisement will remind us ‘investments can go up or down’, and for Enron the focus was on maximizing the ‘up’ and not avoiding, but hiding and contorting beyond all recognition the ‘down’.  As such, it is perhaps the most prominent and extreme case study of a period in history when upside seemed inevitable and a pervasive business problem which sowed the seeds for the economic woes of today was unbridled ‘leadership’ without enough counterbalancing ‘management’.

“It is business wisdom that many of a company’s best deals are the ones it doesn’t do. That was never the belief at Enron, a place that was defined by deal making.”

The most prominent ‘downside’ in business is ‘cost’, and cost was indeed the first area completely ignored by Enron.  It is the definite downside. Without cost, all business is indeed all upside. Early on and throughout McLean and Elkind paint a picture of corporate extravagance on par with the most orgiastic Roman emperors. “Another Skilling precept: a company that worried too much about costs would discourage original thinking…An Enron managing director summed up the philosophy this way: ‘If you are focusing on costs, you’re ***king up.’”

Towards in the end in 2000, this sentiment was reiterated by Enron Broadband Services (EBS) deal chief David Cox in an interview with Fortune: “No shots, no ducks. Nobody gets rewarded for saving money. They get rewarded for making money.”

Early in its history at 1987, the culture of damning the downside was well established.

“Enron Oil was supposed to have strict controls to prevent the possibility of large losses; its open position in the market was never supposed to exceed 8 million barrels…Yet when Arthur Andersen auditors had tried to check whether Enron Oil was complying with the policy, they later reported, they discovered that Borget and Mastoeni had made a practice of ‘destroying daily position reports’.”

This Enron Oil debacle, despite its calamity, nonetheless served as the role model for Enron’s approach to downside. Namely, for every dose of downside experienced, Enron would simply lead its way out of it with twice as much upside. At first blush, it may seem like a noble and appealing strategy. But on deeper examination, one realises that it is nothing more than the “double or nothing” gambler’s fallacy…

“For months, Borget had been betting that the price of oil was headed down, and for months, the market had stubbornly gone against him. As his losses had mounted, he had continually doubled down, ratcheting up the bet in the hope of recovering everything when prices ultimately turned in his direction. Finally, Borget had dug a hole so deep – and so potentially catastrophic – that there was virtually no hope of ever recovering.”

Enron’s crime was that is developed increasingly sophisticated ways of hiding its downside positions. Special off balance sheet vehicles like ‘Raptors’. Bullying of auditors and bankers who were supposed to be scrutinising their practices. Hyping public relations. Miscategorizing of financial items (especially through ‘mark to market accounting’). But it’s ultimate failure as a business lay in its complete and reckless disregard for downside with the obsessive belief that eventual upside would right all wrongs.

This imbalance was not just limited to the financial transactions and bets, but permeated the very culture of the business.  McLean and Elkind offer this commentary which could be applied to so many companies that have thrived in the heady boom prior to the economic downturn highlighting the need for balance between ‘upside leadership’ (‘greed’, ‘free agent’, ‘brilliance’, ‘ideas’, ‘opportunity for creativity’) and ‘downside management’ (‘implement’, ‘structure’).

“Which offers up the problem: no company can prosper over the long term if every employee is a free agent, motivated solely by greed, no matter how smart he is. No company can function if it only hires brilliant MBAs – and sets them against each other. There is a reason companies value team players, just as there is a reason that people who get along with others tend to do well in corporate life. The reason is simple; you can’t build a company on brilliance alone. You need people who can come up with ideas, and you also need people who can implement those ideas and are well compensated for doing so. The pure meritocracy Skilling thought he was installing was, in fact, a deeply dysfunctional workplace. That was hard to see in the early days, when the place felt vibrant and heady and exciting and they all were working so hard that they didn’t have time for anything else. But over the years, as the business became more established, the sense of excitement waned and the dysfunction became more evident. The very qualities Skilling prized – the opportunity for creativity to run wild, the mixture of brain and hubris, the absence of gray hair and structure – turned Enron Finance into a chaotic, destructive free-for-all. Over time, as that culture infected the entire company, Enron began to rot from within. But that came later.”

In 2000, toward the end of Mr. Toad’s Wild Ride, EES back-office manager Glenn Dickson commented, “They touted themselves as a risk-management company, but they never asked what could go wrong. It was a free-for-all – a chaotic, ***king free-for-all.”

The description of the conflicts at Enron Capital and Trade Resources (ECT) provides a colourful articulation of how ‘leaders’ and ‘managers’ misperceive each other…

“The originators viewed the traders as bloodless mercenaries who…’would sell their mom for a buck.’ The traders viewed the originators as dinosaurs, destined for extinction.”

And that tension was specifically manifested between the two main men in the early days, Kenneth Lay and Rich Kinder

“Unlike Lay, Kinder was an utterly practical businessman who saw his job as solving problems and making sure Enron delivered on the earnings targets it promised to Wall Street. Every year, he created a list of Enron’s top ten problems – its alligators – and spent the rest of the year working relentlessly to kill the alligators. He understood the innards of Enron’s various businesses, even the new one Skilling was building. And he commanded respect from Enron’s top executives in a way that Lay never did. ‘Lay was not a good manager,’ says one former executive flatly. ‘Kinder was a good manager.’…Although they got along, there was always some underlying tension between the two men…’Ken was the visionary, and Rich was the deep-down operator.’…the Enron CEO failed to appreciate that it was the company president – and his willingness to roll up his sleeves – who made his grandiose lifestyle possible. ‘There are lots of visionaries,’ says one long term friend of Kinder’s. ‘There are very few people who can actually run a company.’…Many former Enron executives believe that he tempered the company’s natural aggressiveness and brought a sense of discipline it badly needed. He was also the one person at the top of Enron who looked sceptically at things, consistently asking, ‘Are we smoking our own dope? Are we drinking our own whiskey?’”

In the same way that Kenneth Lay was a hero for the excesses of the boom years, I anticipate executives like Rich Kinder becoming the heroes of the new economic reality in the year ahead.  What remains to be seen is whether the risk pendulum swings too far and ten years from now we will be reading stories of opportunities missed by executives too focused on avoiding downside to pursue them.